401(k) Survival Guide: Discover the Top 5 Options for Your Old 401(k)!

What Can You Do With Your Old 401(k)? We Help You Navigate the Maze of Options for Your Old Retirement Fund!

Today, we’re tackling a big question: What should you do with your old 401(k)? I’ll walk you through five options, including one I would strongly stay away from but will explain for clarity. From leaving your funds as they are — to considering a direct rollover into an IRA, each choice has its upsides and downsides. Let’s break it down so that you can make an informed decision about your retirement savings.

So, What Should You Do With Your Old 401(k)?

Let’s kick off with the first option: Do Nothing!

Doing Nothing essentially means leaving your 401(k) plan as it is, assuming your employer allows it.

While it might seem like the easiest route, there are some details to keep in mind like dealing with customer service, it could prove a bit tricky. However, there are some perks to keeping your funds within the original 401(k) plan, and we are going to walk through a few of them here. One significant advantage is potentially having the option of accessing your money early without facing penalties, maybe starting as early as age 55 instead of the standard 59.5. Another pro is if you have a substantial portion of company stock in your 401(k), this could potentially open doors to special tax benefits and eligibility for plan loans. Another advantage of keeping your funds in the 401(k), is the potential for federal debtor protection, helping to ensure the safety of your retirement savings in case of bankruptcy. However, it’s essential to weigh these benefits against the drawbacks.

One significant drawback is the possibility of having multiple 401(k) plans or employer-sponsored accounts scattered across various companies, leading to confusion and difficulty in tracking investments. This fragmented approach can make effective management of your overall investment picture very difficult and may result in missed opportunities for optimizing your funds.

Let’s also not forget, that you may not be permitted to keep the money in the plan. But even if you could leave it in, many 401(k) plans offer very limited investment choices, which can hinder your ability to maximize future returns. With only a handful of options available, such as target date funds, your portfolio’s expected return is likely to be lower than desired. Additionally, managing multiple plans simultaneously can be challenging, making it difficult to stay informed and in control of your investments. Despite these challenges, if you determine that keeping your money within the current 401(k) plan is the best course of action, the simplest approach is to take no action and inform your employer or plan administrators accordingly. Of course, there is also the chance you may not need to notify anyone, and everything could proceed smoothly. However, it’s crucial to carefully assess all factors before settling on this option.

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This brings us to option 2: Transferring to your new employer’s 401(k) plan.

You might consider transferring your old plan to your new employer if you’re still working and have found a new job. While it’s unlikely that your new employer may not allow the transfer, most of the time it’s not an issue. In most cases, you will be able to transfer your 401(k) from your old employer plan to the new one. There are several advantages to this approach. First, consolidating your accounts into one plan helps streamline your financial management, especially if you have multiple 401(k) plans scattered across different companies. Secondly, transferring your funds typically provides similar creditor protections to those offered by your previous 401(k) plan, helping ensure the security of your investments can remain intact.

Another advantage of transferring your old plan to your new employer is the potential tax benefit. Unlike withdrawing all the funds from your old 401(k), which incurs taxes, rolling it into your current plan allows you to consolidate your assets without triggering tax implications. However, it’s essential to note that some employers may have eligibility waiting periods for their 401(k) plans, which could delay your ability to access the plan. Additionally, if your new plan offers limited investment options, it may hinder your ability to diversify your portfolio effectively. Many clients I assist often face this issue. After they transfer, they discover the investment choices available in their new 401(k) plans are not as good as their old plan, which can limit their ability to optimize their investments.

Choices Within 401(k) Plans Seem to be Decreasing

The decreasing number of investment options within 401(k) plans presents a challenge for employees looking to optimize their portfolios. Year after year, the available investment options seem to get more and more sparse, making it increasingly difficult to manage investments effectively. However, If you do opt for a rollover, the process involves contacting your former employer’s company and coordinating with the HR department at your new company. Be prepared though for a substantial amount of paperwork, back-and-forth communication, and potentially long wait times on the phone. Despite the administrative hassle, eventually, you’ll likely be able to transfer your funds from your old 401(k) plan to your new employer’s 401(k) plan. But it won’t be without some legwork involved.

Now, onto the third option, which I must emphasize is MY LEAST FAVORITE. Cashing Out Your 401(k)

Cashing out your 401(k) and withdrawing all the funds, while technically your money, is generally considered a VERY poor financial decision due to tax implications and penalties.

While you have the option to withdraw funds from your 401(k) plan, I strongly suggest against it. It’s tempting to access the money, especially if you’re facing financial challenges, but it’s important to consider the long-term consequences. Withdrawing from your 401(k) means tapping into your retirement savings, which you’ll likely need later in life. Additionally, taking out funds triggers a tax bill, as well as penalties. For example, if you withdraw $100,000, you’ll owe taxes on that amount, which could significantly reduce your overall payout. This tax deduction was originally applied when you contributed to the plan, but now, upon withdrawal, taxes must be paid. Moreover, you’ll incur additional penalties on top of the taxes owed, making early withdrawals from your 401(k) a costly decision in the long run. You’ll face these penalties for an early distribution, typically if you’re under 59.5 years old, unless you qualify for an exemption.

Now, let’s weigh the pros and cons. One advantage is immediate access to cash. However, this benefit is outweighed by the substantial reduction due to penalties, fees, and taxes. It might seem like a quick fix, BUT withdrawing from your 401(k) should be THE last resort. You’re essentially borrowing from your future to meet current needs, which can have lasting consequences on your financial well-being. If you find yourself in dire circumstances with no other options, it’s crucial to seek guidance from a portfolio manager before making this decision. Early withdrawals can inflict permanent damage on your future financial plans, making professional advice essential in navigating this challenging situation.

Now, let’s consider the fourth option: an INDIRECT ROLLOVER to an Individual Retirement Account (IRA).

An Indirect Rollover can be done, but it’s not as straightforward as it seems. Essentially, your old plan administrator will issue you a check. You’ll then establish an IRA with a provider like Fidelity, and you will have to deposit the check into the new account within a 60-day window. Failure to meet this deadline could result in taxes, fees, and penalties, similar to cashing out your 401(k) directly. The advantage here is you have temporary access to the cash for 60 days, potentially serving as a short-term bridge loan if needed.

Here are a few of the cons to consider. First, you’ll need to ensure you deposit the check within the 60-day timeframe, as failure to do so may result in taxes and penalties. Another complication arises if your employer withholds a portion of the distribution to ensure compliance with tax regulations. The transaction will be reported to the IRS, so it’s essential to follow the process diligently. During this period, not only could you risk missing out on potential market gains since the funds are not invested, your employer might withhold 20% of the amount, creating a shortfall when depositing into the new plan. While not always the case, you may need to cover this withheld amount out of your own pocket to fulfill the rollover requirement. This can be tough to manage if you have a sizeable 401(k).

For Example:

Let’s say you have a $500,000 401(k) and you opt for an indirect rollover. Let’s also assume your employer withholds 20% — or $100,000. You may need to cover this $100,000 within the 60-day period — something you might not want to try to do.

Further issues are that you’re also limited to one rollover per 365 days, and there may be associated high fees, along with trying to decide where to invest the funds can also be challenging. Nonetheless, indirect rollovers remain a viable option.

Moving on to the fifth option, ( and probably the best ) you can opt for a DIRECT ROLLOVER, also known as a TRUSTEE TO TRUSTEE rollover.

This involves transferring funds directly from one retirement plan to another, typically an IRA. While there is paperwork involved, you would typically collaborate with a portfolio manager to navigate this process smoothly — and they would handle most of the heavy lifting. One significant advantage is the wider range of investment options available with an IRA, providing more flexibility for your retirement savings strategy.

When guiding our clients through this process, we focus on constructing a diversified portfolio that aims to maximize future expected returns while minimizing risk. Although there’s some paperwork involved, we assist our clients every step of the way to navigate through it seamlessly and avoid potential pitfalls. Compared to other options, direct rollovers or trustee-to-trustee rollovers require less complexity and involve fewer risks. However, it’s essential to note one drawback common to all these options: the loss of creditor protection that comes with moving funds out of a 401(k).

Direct Rollover Issues

If you’re concerned at all about protection against lawsuits or bankruptcy, leaving your funds in a 401(k) can provide more security compared to rolling them over into an IRA. Another drawback is that engaging in rollovers could affect your ability to execute a backdoor Roth strategy in the future. Additionally, while it’s unlikely, there’s a possibility that the fees associated with an IRA could be slightly higher than those of your 401(k). This is something worth discussing with your portfolio manager to determine if the potential benefits of better investment options outweigh the increased fees.

Here’s The Bottom Line:

When it comes to your old 401(k) you essentially have five options: leaving your funds where they are, transferring them to your new employer’s plan, avoiding a cash distribution (which is strongly advised against), considering an indirect rollover (though it’s not straightforward), or opting for a direct rollover. Each option comes with its own set of considerations and potential implications for your financial future, and deciding what to do with your old 401(k) involves careful consideration of the various factors and options. Whatever option you decide to choose, it’s crucial to weigh the pros and cons carefully and seek professional advice if needed.

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Joe A. Macek, FMA, CIM, DMS, FCSI

Investment Advisor, Portfolio Manager

iA Private Wealth | iA Private Wealth USA

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